Trusts as a Planning Strategy 

Trust Options


There are many different types of trusts that can help alleviate the effects of gift and estate tax and direct the flow of your wealth transfer. By designing a well-planned trust strategy, you can transfer your wealth in the most efficient way possible.


Grantor retained annuity trusts (GRATs)


A GRAT is a type of trust that makes annuity payments back to its grantor over a number of years and then transfers any remaining value to a beneficiary. When a GRAT is created, the IRS uses a set growth rate (called the 7520 rate) to estimate the trust’s future value. It then subtracts the annuity payments from the future value to determine the remainder—the only portion taxed as a gift. Because GRATs are taxed upfront, any excess growth (growth above the 7520 rate) will be not be subject to gift taxes. Therefore, grantors often select annuity payments that equal the IRS’s expected future value, creating a GRAT that incurs no gift tax and leaves all excess growth as the remainder.


Common recommendations include keeping the term length of a GRAT relatively short, depending on the time horizon, or creating several short-term GRATs rather than one long-term GRAT. The reason for this is that if the grantor dies prior to the expiration of the GRAT term, the GRAT will fail in its purpose and all assets will remain subject to estate tax. For this reason, many opt for a “rolling GRAT;” which is a series of consecutive short-term GRATs. This technique also helps to hedge some of the risk of market fluctuations. However, short-term and rolling GRATs require larger annuity payments, so if there isn’t a large amount of liquid assets available, a long-term GRAT may be more effective.


Things to keep in mind when considering GRATs:

  • GRATs are still subject to income taxes.

  • GRATs are irrevocable—they cannot be changed or terminated.

  • GRATs are legally required to pay annuities, regardless of growth.


Grantor retained unitrusts (GRUTs)


GRUTs are almost identical to GRATs, with the only difference being in how annual payments are determined. Instead of returning a fixed amount, GRUT annuities are a percentage of the trust’s value that year. That means that the income distributions will be less stable and may be higher one year, but lower the next.


Irrevocable life insurance trusts (ILITs)


ILITs are trusts designed to hold the life insurance policy of their creator. An ILIT essentially removes your life insurance policy from your official property, thereby protecting it from estate taxes. This type of trust also provides the surviving beneficiaries with funds while not passing into their estates, which helps avoid estate taxes as well. ILITs can help grantors feel secure because they guarantee that no matter how much a grantor spends in their lifetime, their beneficiaries will still receive an income after their death from their life insurance policy.


When considering ILITs, keep in mind the following:


  • It takes three years after the ILIT is created for the IRS to consider the trust as outside the grantor’s estate.

  • A provision known as Crummey powers allows beneficiaries to take small gifts annually from the trust for a brief period of time (usually 30 days). This allows beneficiaries to avoid gift taxes by taking the funds out in small amounts rather than receiving the total value of contributions as a large gift once the grantor dies.


Intentionally defective grantor trusts (IDGTs)


IDGTs are trusts that make the grantor the owner of the trust for income tax purposes but not for estate tax purposes. Using a trust with the word “defective” in its name may seem counterintuitive, but this simply refers to the fact that the grantor is taxed on the income the trust receives. The “intentional” part of the trust hints at the fact that this type of taxation allows the trust itself to remain untouched, leaving more money for the grantor’s future heirs. This “defect” in the trust is what makes it such a useful tool for generational wealth transfer.


This type of trust essentially freezes assets for estate tax purposes by allowing them to grow outside of their estate without income tax reductions, as the trust income tax is applied to the grantor instead of the trust itself. Since the tax rates escalate much more quickly for trusts than for individuals, this type of trust helps to save on overall income tax by putting the taxes in a lower bracket. As of 2015, trusts that earn over $12,300 will be taxed at a 39.6 percent rate—an individual would have to make over $413,200 before he or she was subject to those same rates.


Choosing a trust to aid your wealth transfer plan can be tricky, so it’s important to work with legal and financial professionals to do so. You should consider the unique aspects of each trust and whether or not they fit with your wealth transfer plan and your family’s needs. Whether you choose one type of trust or a combination of trusts, the most important thing is that you pass on your money in a way that makes you feel secure about the future of your legacy.


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